A big bet on transatlantic flying has paid off for long-suffering investors in British Airways owner IAG, as a yearlong rally lifts the airline group’s shares to their highest level since the start of the pandemic.
Shares in IAG, the owner of five carriers including BA, Iberia and Aer Lingus, last week closed just under 316p, the highest level since February 2020. The stock was down on Monday, but it more than doubled last year to make it the top performer on London’s FTSE 100.
The turnaround in the company’s fortunes came as investors cheered a second consecutive summer of record profits built on lucrative transatlantic flying, which has seen particularly strong demand since the end of the pandemic.
“They have focused on where they can fly to win,” said Andrew Lobbenberg, head of European transport equity research at Barclays.
This allowed IAG to pay off its outstanding pandemic debt and reinstate its dividend. It also announced a €350mn shareholder buybacks late last year, the first since the pandemic.
“Demand remains strong across the Atlantic and within Europe,” said Nicholas Cadbury, IAG’s chief financial officer, adding that the group’s shares were supported by “significant cash flow and increasingly strong balance sheet”, which increased investor returns.
One of the biggest questions now hanging over IAG is whether a £7bn investment plan in British Airways can improve service and reduce delays and other operational problems at its main profit generator.
The airline has faced criticism in the past — notably from customers and unions — for seemingly prioritising shareholder returns over customer experience and quality.
Improving BA “should be a continuing, strong driver of profit momentum for the group”, Lobbernberg said, particularly given that the airline had a stranglehold on Heathrow, one of the most lucrative travel markets in the world.
“They should be making a strong profit. So, its performance of late has been very poor because it has been under invested in.”
IAG’s business model is geared towards long-haul travel and in particular its business and first-class cabins, parts of the industry which were slower to recover following Covid but are now booming.
“If you want exposure to the Transatlantic and premium travel then IAG is the play you want to look for,” said Julian Cook, a partner at ATKA Capital, a London-based hedge fund that focuses on aviation.
ATKA sold a stake in Ryanair last year to buy IAG, which was a “no brainer” according to Cook.
“We could see the Atlantic was performing well and wanted to play the premium end of the market,” he added.
Even after the rally, IAG shares are still only trading on a price/earning ratio of about 6.5 times, less than Ryanair and easyJet.
IAG’s major hubs in London, Dublin and Madrid are at the westernmost edges of Europe, giving it a natural advantage in flying across both the north and south Atlantic.
The group has doubled down on these routes since the pandemic at the expense of flights to Asia, where demand has been slow to return and European carriers face the complexity and cost of having to avoid Russian airspace.
Three-quarters of IAG’s long-haul routes are to the Americas, more than the 53 per cent at Lufthansa Group and 54 per cent at Air France-KLM, according to analysts at Bernstein.
This focus on the Atlantic has also allowed IAG’s airlines to dodge competition from deep-pocketed and expanding rivals in Turkey and the Gulf, where European airlines struggle to compete on costs and fares, as well as service standards.
In contrast, the US and Europe routes have become more profitable compared to pre-pandemic levels since the collapse of Norwegian in 2020, which had disrupted incumbent carriers with low-cost fares.
“Fly west rather than east is the better long-haul strategy after the pandemic, especially from London”, Bernstein transport analyst Alex Irving said.
Analysts said other questions now facing IAG included whether demand for flying in its key markets can hold up, as well as the possibility of increased geopolitical tensions, particularly from a second Trump presidency.
There is also uncertainty over future M&A, after a bid to grow its position in the Latin American market by buying Spain’s Air Europa was rejected last year by European competition authorities.
IAG’s management has told investors it is focused on hitting financial targets set out in 2023, which include increasing its operating margin to between 12 and 15 per cent, up from 11.9 per cent in 2023.
Its other targets include growing its flight schedules between 4 and 5 per cent a year, and a return on invested capital of between 13 and 16 per cent. Typically airlines generate single-digit ROI, according to Bernstein’s Irving.
“In the context of other European flag carriers they are not only the most profitable but they are the most shareholder-friendly, they have clear financial targets for each of their units and allocate capacity to those units according to their earning performance,” Cook said.
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